Fair Winds and Following Seas The sea, its perils and fair lending management? Timothy R. Burniston Executive Vice President, WKFS Consulting

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1 Fair Winds and Following Seas The sea, its perils and fair lending management? Timothy R. Burniston Executive Vice President, WKFS Consulting

5 SEA CAPTAIN: Responsible for operating ships in lakes, rivers, bays and oceans. Directs crew, operates boat, and ensures safe port Command vessels in various bodies of water Hire and supervise ship crew members Stick to planned route Resolve problems with customers Use flashing lights and whistles to signal passing vessels Signal tugboats Monitor loading of cargo Record ship positions and movements

6 Ship Captain Command vessels in various bodies of water (lakes, rivers, bays, and oceans) Hire and supervise ship crew members Stick to the planned route Resolve problems with customers Use flashing lights and whistles to signal passing vessels Signal tugboats Monitor loading of cargo Record ship positions and movements Fair Lending Officer Develop, implement, lead and oversee the bank s fair lending program for various product lines (auto, credit card, student loans, and mortgages) Build and manage the fair lending analytical team Develop and implement a monitoring program that follows a set schedule of periodic reviews Administer the bank s fair lending consumer complaint response program Keep senior management and the Board of Directors informed of emerging risks and issues pertaining to fair lending examinations Maintain routine contact with primary regulators regarding the introduction of new products and changes in the administration of the bank s fair lending program Administer the bank s HMDA reporting system with particular emphasis on the entry of accurate data Document changes in the bank s fair lending risk profile through the conduct of fair lending risk assessments

7 Today s Topics Disparate Impact. What is it? How is it distinguished from disparate treatment? What did the recent Supreme Court decision do? How can we be proactive? Redlining. How are regulators approaching redlining reviews? How can we monitor and review our operations to avoid possible redlining claims? Fair Lending Management. What are regulators expecting from banks? How can you prepare for your next examination? How can smaller banks prepare who don t have a lot of data?

8 Disparate impact is a form of discrimination that occurs when a lender applies a facially-neutral policy or practice equally to credit applicants, but the policy or practice has a disproportionate adverse impact on applicants on a prohibited basis. Policies and practices that are neutral on their face and that are applied equally may still, on a prohibited basis, disproportionately and adversely affect a person's access to credit. Disparate treatment is defined as discrimination in which a lender simply treats some people less favorably than others because of their race, color, religion, sex, or national origin or other prohibited basis.

9 Disparate impact focuses not on discriminatory intent as disparate treatment often does, but instead on discriminatory consequences. Proof of discriminatory motive is not required under a disparate-impact theory.

10 Discretion One of the most significant fair lending risk factors giving rise to disparate impact claims. Instantly draws examiner attention.

11 U.S. Supreme Court Disparate Impact Case Texas Department of Housing and Community Affairs v Inclusive Communities Project 5-4 decision Court held that specific language in the FHA permits plaintiffs to challenge housing practices that have an unintentional but disproportionate adverse impact on minorities Practices have to be artificial, arbitrary, and unnecessary as well as unjustified by a legitimate rationale in order to violate the Fair Housing Act

12 Proactive Measures Disparate Impact Clear, written policies and procedures that set forth the limits of any discretion. Review policies for potential disparate treatment as well as for possible disparate impact. Ensure that you stick to the plan. That means no exceptions to the charted course unless those exceptions are dictated by business necessity. When exceptions inadvertently occur despite the presence of monitoring programs and rigid controls, they need to be quickly identified and documented.

13 Proactive Measures Disparate Impact Reasons for any exceptions must be thoroughly investigated. Track exceptions and report them internally. Evaluate the relationship between exceptions and one or more prohibited bases. Monitor and scrutinize third party conduct.

14 Proactive Measures Disparate Impact Look closely at CFPB s supervisory guidance on indirect auto lending, which states: supervisory experience suggests that where significant limits on discretionary pricing are in effect, they may result in considerable reductions or effective elimination of markup disparities for the particular product or business line subject to the limit. Significant limits on markup, such as a limit of 100 basis points, may reduce fair lending risk. CFPB also mentions the alternative of eliminating deal pricing discretion altogether in favor of a flat fee structure if you eliminate discretion, you eliminate the need for monitoring.

15 Redlining What is redlining? Redlining typically refers to a form of disparate treatment in which a lender provides unequal access to credit or unequal credit terms because of a prohibited-basis characteristic of residents of the area where a loan applicant resides or will reside or where the residential property to be mortgaged is located. Redlining does not necessarily mean the total absence of lending within minority areas. It can also be identified when a bank s lending level in minority areas is not comparable with lending levels in nonminority areas, especially when factors such as competition, demographics, and economic conditions are considered.

16 Redlining Red Flags Higher rates of applications denied, withdrawn, approved but not accepted or closed for incompleteness in areas with concentrations of minority group residents. Failing to offer certain products in MSAs, political subdivisions, census tracts, or other geographic areas within the institution s lending market with concentrations of minority group residents. Differences in the branch office accessibility, services available, or hours of operation at branch offices located in areas with concentrations of minority group residents.

17 Redlining Red Flags Lack of branches in minority areas or a branching strategy that appears to treat census tracts differently on a prohibited basis A marketing and outreach strategy that appears to treat census tracts differently on a prohibited basis. CRA assessment areas that appear to have been delineated in such a way as to exclude areas with relatively high concentrations of minority residents. Consumer complaints raised by consumers of consumer advocates indicating the institution treats certain geographies differently on a prohibited basis.

18 Common peer group attributes Business models Loan products Loan market share Branch, office, and broker/third party locations Deposits and deposit market share Peer groups should also be established on a market-by-market basis. There should also be a review undertaken to ensure that the peer group is stable over the evaluation period. For example, if there were changes in the institution base over the evaluation period, refinement on a yearly basis is probably appropriate.

19 Redlining What you need to know Know your ocean What are the demographics of your market area? How diverse are the neighborhood characteristics in the markets covered by the assessment area? Just outside the assessment area? Are there demographic changes in the market area that are not yet reflected in census data? Does the bank s strategic growth plan incorporate changes to the demographic characteristic of its market service area? What are the primary credit needs?

20 Redlining What you need to know Know your wind direction Systematically review the geographic distribution of residential loans among high minority, minority, and nonminority census tracts. Does the geographic pattern of lending differ by the concentration of residents of a particular racial or national origin group? What are the reasons for any lending gaps? Do other lenders make loans in areas in which the bank has gaps? If so, can the bank account for the difference in the bank s lending patterns compared to other lenders?

21 Redlining What you need to know Know your wind direction Assess the reasonableness of the bank s lending taking into account: Homeownership rates across geographies Marketing strategies and ending strategies; Branch locations, branch placement, and branch closing decisions (if relevant) The lending record of similarly-situated lenders in the bank s market.

22 Redlining What you need to know Know your wind direction Test loans or use statistical analysis of loan distribution among high-minority, minority, and nonminority tracts. Are differences evident in the number of applications received, withdrawn, approved but not accepted, and closed for incompleteness in areas with high concentrations of residents of a particular racial or national origin group? Are there differences between approval/denial rates in areas with relatively high concentrations of minority group residents compared to areas with relatively low concentrations of residents of such a racial or national origin group?

23 Redlining What you need to know Know your wind direction Review reasons for denial, especially for low appraisal or insufficient collateral. Does the bank s CRA delineated assessment area exclude any adjacent high minority or minority census tracts?

24 Redlining What you need to know Know your ship Where are your branches? What has been the pattern, if any, of closing branches? What support do you have for branch closing decisions? Has the bank looked at alternatives to closing branches or what can be put in place to support the community once a branch is closed? What are your future branching plans? Are there differences in products, prices, hours, and services at the branch level?

25 Redlining What you need to know Know your ship Are there variations in marketing based on geography? If so, could this leave the impression that the bank favors some areas over others? Do marketing programs for residential loan products exclude any regions or geographies within the bank s assessment areas that have significantly higher percentages of residents who are racial or national origin minorities? Can your bank demonstrate active outreach to and involvement with community development and advocacy organizations?

26 Compliance Management Systems - Overview Board and Senior Management Oversight Compliance Program Policies and procedures Training Ongoing monitoring and corrective action Compliance Audit Consumer Complaint Management

27 Fair Lending CMS An up- to- date fair lending policy statement Regular fair lending training for all employees involved with any aspect of the institution s credit transactions, as well as all officers and board members Ongoing monitoring for compliance with fair lending policies and procedures Ongoing monitoring for compliance with other policies and procedures that are intended to reduce fair lending risk (such as controls on loan originator discretion)

28 Fair Lending CMS Review of policies for potential fair lending violations, including potential disparate impact Depending on the size and complexity of the financial institution, regular statistical analysis of loan data for potential disparities on a prohibited basis in pricing, underwriting or other aspects of the credit transaction Regular assessment of the marketing of loan products Meaningful oversight of fair lending compliance by management and where appropriate, the financial institution s board of directors.

29 Some advice for smaller institutions Do something ANYTHING! Keep you fair lending policy current and include all the prohibited bases of discrimination Read the fair lending examination procedures for your regulator. Understand your products, your markets, and how you sell. Do a fair lending risk assessment. Conduct self reviews using basic analysis in Excel. For example, LTV over typical LTV who shows up? Do males show up more than females Set a schedule for the reviews and stick with that schedule.

30 Some advice for smaller institutions Be tough on yourself. You can explain away every denial in your bank, but it is when you look at approvals and compare that you start to see the problems. When do you bend the rules and for whom do you bend them? Do comparative file reviews of similarly situated applicants Conduct focal point analyses to review lending performance against various marketing, underwriting or pricing benchmarks to identify any outlier disparities that would necessitate further study.

31 CFPB RISK PRIORITIZATION Complaints, outreach, tips, and litigation Supervisory history of the institution Quality of the Fair Lending CMS Data analytics (HMDA) Contribution of its market teams.

32 Why do a Fair Lending Risk Assessment? Identify areas where the institutions needs to spend time Pinpoint areas where examiners are going to focus Highlight potential issues for senior management and the Directors Help determine whether the level of risk present is consistent with or different from your risk appetite Mitigate penalty/adverse supervisory action situations when done correctly

33 Common Problems with Fair Lending Risk Assessments Not involving the business and functional unit managers. They know where the risk is Not looking at risk across the entire product lifecycle Omitting certain products Ignoring consumer complaints Underestimating the time needed to do the work

34 Common Problems with Fair Lending Risk Assessments Failing to leverage data generated by fair lending monitoring activities Underestimating inherent risk inherent risk is low because controls are good Forgetting that risk is continuous and treating the risk assessment process as a one-time/point-in-time exercise Not communicating the results across the institution and mobilizing all three lines of defense.

35 How to Ensure a Robust Fair Lending Risk Assessment Conduct extensive scoping as part of the inherent risk process Build partnerships and collaborate across business lines Adopt a consistent, uniform approach for conducting risk assessments Evaluate items that change your risk profile and lead to updating your risk assessment Align fair lending monitoring and testing activities Do it again

36 New HMDA Preparation: START NOW!! Identify all lines of business that will be impacted by the HMDA changes. Develop an implementation plan. Identify and prepare for any needed staff training and technology investments. Strengthen and bolster the organization s analytical capabilities.

37 Precepts for Regulatory Relationships Credibility: Basic Element of Trust; Expectation of Courtesy and Cooperation Communications: Clear, Complete and Open Mutual Understanding: Know What Your Regulator & Others Are Up To & Use Their Resources

38 Examination Process Overview Pre-Exam Ongoing Monitoring On-Site Exam Remediation Understand Examination Findings

39 Basic Fair Lending Exam Preparation Review Prior Examination Materials; Internal Reviews and Audits Know Your Story and Be Able to Tell It Conduct and Document Credible Fair Lending Risk Assessments Establish Points of Contact for Examination Respond to Pre-Exam Requests for Information

40 Manage the Onsite Examination Regular Meetings with Examiners Establish Escalation Processes Central Point of Contact Communicate with Executive Management Monitor and Manage Responses to Examiners

41 Understand Examination Findings Thoroughly Understand Exam Findings Before the Examiners Leave. Ask Questions. Review Report of Examination and Exam Recommendations, Violations, and MRA s. Seek Clarity when Necessary. Develop Action Plan with Board Approval and Regulatory Concurrence. REMEMBER: Promises Made are Promises Kept

42 Remediation Matters Requiring Attention Root Cause Analysis Action Plan Remediation Validation of Remedial Actions

43 Ongoing Monitoring Review Risk Assessments Policy and Practice Reviews Validation of Training Analyze Data Integrity Reviews Data Analysis Prepare Regular Communication with Regulator Pre-Exam Self Assessments 43

44 Details Matter Have you conducted a comprehensive fair lending risk assessment that covers all your products? Have you acted on the results of that risk assessment? Are all aspects of your CMS and fair lending CMS up to regulatory expectations? Can you document all your monitoring, review, and training activities, as well as follow-up actions on previous commitments? Can you communicate the results to your examiners?

45 Details Matter Are you ahead of the curve with regard to data analytics? Have you analyzed your applications and loans for potential disparities? Have you received a request for new information? Have you responded? Was your response timely? Are your responses clear, complete, and accurate? Have you established the precise date for the examiners next on-site supervisory activity? Have you determined, in conjunction with the examiners, their needs and objectives for the planned supervisory activity?

46 Details Matter Have you named a POC to manage regulatory communications throughout the examination or other supervisory activity? Is that POC in touch with legal counsel and senior management/ During the supervisory event, how will your maintain regular communications with the examination team? Have you made certain that your communications are handled by the responsible parties and are both consistent and accurate throughout the examination? Have you ensured that senior management is aware of any substantive supervisory issues arising in the course of the examination?

47 Details Matter Has the institution s senior management team been briefed in advance of the exit meeting? Have you developed a suitable Action Plan to respond to any MRAs? Have you identified someone as accountable for each MRA? Do you have a process for monitoring and documenting progress in responding to each MRA? Have you developed dashboards or key indicators to monitor performance going forward? Are you ready for your next examination?

48 Fair Winds and Following Seas

Managing Fair and Responsible Lending Challenges and Risks

Managing Fair and Responsible Lending Challenges and Risks NYBA Technology, Compliance and Risk Management Forum White Plains, NY May 13, 2015 Legal Counsel to the Financial Services Industry Presented